The Welfare State and Taxes
The public school, the health clinic, the paved streets, the firefighters: almost none of this is paid for at the moment you use it. It is financed in advance, by everyone together, through taxes collected by the SAT (Mexico's tax authority). In this section you will see how that financing is organized, what the difference is between paying according to what you earn and paying according to what you spend, and what really happens when a tax goes up.
The welfare state: what are taxes for?
This rests on the principle of solidarity: people who are healthy and earn well contribute to services they may never use, because tomorrow they or their family might need them, and because a society with health care and education for everyone is more productive and safer for everyone.
Explain what the welfare state is and what services taxes fund in Mexico. Where does the money for a public school or a public hospital come from?
Explain what the welfare state is and what services taxes fund in Mexico. Where does the money for a public school or a public hospital come from?
Direct and indirect taxes: income, consumption, and wealth
With a direct tax, the person who pays it to the SAT is the one who bears the burden, and the amount depends on their personal situation. With an indirect tax, the seller turns it in, but the buyer pays it in the price, no matter how much the buyer earns.
Distinguish between direct and indirect taxes and classify the following: VAT, personal income tax, corporate income tax, and gas tax. Who pays them and what are they…
Distinguish between direct and indirect taxes and classify the following: VAT, personal income tax, corporate income tax, and gas tax. Who pays them and what are they levied on?
The IVA in numbers
The IVA is calculated by multiplying the price before tax by the rate. With the general rate of 16%, the final price is the pre-tax price multiplied by $1.16$.
Notice that the IVA is proportional: it is always the same percentage of the price, no matter who is buying. It is indirect because the buyer pays it when consuming, even though the store is the one that turns it over to the SAT.
A bicycle costs $\$8\,000$ excluding VAT and the standard rate of $21\ \%…
A bicycle costs $\$8\,000$ excluding VAT and the standard rate of $21\ \%$ is applied.
- a) Calculate the VAT and the final price.
- b) Explain why VAT is considered an indirect tax.
Progressivity: rates, brackets, and the average rate
In Mexico, the ISR on individuals is progressive: a table with brackets, each with a higher rate.
One country has a single tax rate of $20\ \%$ on income; another uses tax brackets: $10\ \%$ up to $\$200\,000$ and $30\ \%…
One country has a single tax rate of $20\ \%$ on income; another uses tax brackets: $10\ \%$ up to $\$200\,000$ and $30\ \%$ above that amount.
- a) Calculate how much a person earning $\$200\,000$ and another earning $\$600\,000$ pay under each system.
- b) Which system is progressive and which is proportional? Explain the difference.
The figure compares two income taxes: a flat-rate tax and a progressive bracket tax. On the horizontal axis, annual income; on the vertical axis, the effective rate…
The figure compares two income taxes: a flat-rate tax and a progressive bracket tax. On the horizontal axis, annual income; on the vertical axis, the effective rate paid.
- a) Read what effective rate an annual income of $\$40,000$ pays under each system.
- b) Explain which curve corresponds to each system and what it means that one increases while the other does not.
Average rate and marginal rate with calculations
Explain the principle of solidarity in funding the welfare state and apply it to this case: a healthy person with a good salary pays taxes that fund a hospital they…
Explain the principle of solidarity in funding the welfare state and apply it to this case: a healthy person with a good salary pays taxes that fund a hospital they might not set foot in for years. Why do we accept this system?
An annual salary of $\$480\,000$ is taxed in brackets: $0\ \%$ up to $\$240\,000$, $20\ \%$ from $240\,000$ to $\$400\,000$, and $30\ \%$ above $\$400\,000$. a)…
An annual salary of $\$480\,000$ is taxed in brackets: $0\ \%$ up to $\$240\,000$, $20\ \%$ from $240\,000$ to $\$400\,000$, and $30\ \%$ above $\$400\,000$.
- a) Calculate the total tax and the effective average rate.
- b) Compare the average rate with the marginal rate (the rate paid on the last pesos earned) and explain why confusing them leads to mistakes in public debate.
Tax incidence: who really pays?
The government is considering raising a tax and is deciding between VAT on movie tickets and VAT on sugary drinks. a) Analyze each option using three criteria: expected…
The government is considering raising a tax and is deciding between VAT on movie tickets and VAT on sugary drinks.
- a) Analyze each option using three criteria: expected revenue (think about the elasticity of demand), health impact, and equity (who is affected most).
- b) Decide on and defend your proposal as if you were the tax advisor.
Effects of taxes on work
An income tax reduces what you receive for each hour worked, and this can change how much you work through two opposing effects:
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Substitution effect: each hour is worth less after tax, so free time becomes "cheaper" and people tend to work less.
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Income effect: with less net income, to maintain your standard of living you tend to work more.
In a parliamentary debate on taxation, one member of parliament states: "If we raise the top marginal income tax rate from $45\ \%$ to $60\ \%$, revenue will fall…
In a parliamentary debate on taxation, one member of parliament states: "If we raise the top marginal income tax rate from $45\ \%$ to $60\ \%$, revenue will fall because high earners will stop making an effort or leave the country." Another MP replies: "On the contrary, to maintain their net standard of living after tax, professionals will have to work even more hours, so we will collect more."
- a) Identify the two opposing microeconomic effects (substitution effect and income effect) underlying each MP's argument and explain how each affects the labor supply.
- b) Use the logic of the Laffer curve to predict under what empirical conditions the first MP would be right and under what conditions the second would be right.
- c) Imagine you are advising the Ministry of Finance: what empirical variables or indicators (labor supply elasticity, international tax mobility, avoidance opportunities) would you ask to analyze before setting that $60\ \%$ rate, comparing it to a moderate rate of $20\ \%$?
Tax avoidance and tax evasion
Back to the beginning: public schools and hospitals come from everyone's taxes; and when a tax goes up, the one who remits it to the SAT is not always the one who bears it: the elasticity of supply and demand decides how the burden is shared.